Cliff Negotiators Grapple With Tax Issues

By

Janet Hook

Updated Dec. 29, 2012 6:04 p.m. ET

WASHINGTON—Senate Republican and Democratic leaders worked Saturday to bridge differences over how to avoid year-end tax increases and possibly spending cuts, and found themselves grappling not only over income tax rates, but also over a thorny side issue of estate taxes.

Aides to Senate Majority Leader Harry Reid (D., Nev.) and Senate Minority Leader Mitch McConnnell (R., Ky.) met in a largely empty Capitol, seeking to lay the groundwork for a compromise that would extend current tax rates for most Americans and at least blunt the impact of the so-called fiscal cliff.

The most intense scrutiny is on the income-tax rates that will expire and be replaced by higher Clinton-era rates if Congress does not act by Jan. 1.

Republicans have conceded that rates will go up for wealthier Americans, and talks are centering on GOP efforts to reduce the number of people in that category. President Barack Obama wants taxes raised on income over $250,000; Republicans have said they want the threshold to be raised to at least $400,000.

The estate tax has emerged one potential sticking point, as key Republicans insist that the levy be kept at current levels rather than rising as Mr. Obama and many Democrats want. The issue also divides Democrats, with some farm-state senators joining the GOP in favoring a lower rate, making the politics of the estate tax particularly tricky.

Democratic officials close to the talks say the president has said he would not give Republicans concessions on both income and estate taxes. If he agreed to move the income tax threshold up from $250,000, Republicans would have to accept an increase in the estate tax, these officials said.

Mr. Obama told the GOP in the Friday meeting with top leaders at the White House that Republicans would have to accept a higher estate tax if they also wanted to raise the income threshold to $400,000.

As senior Senate staff continued negotiating into the evening Saturday, a senior GOP aide said only, "Discussions are under way." A Democratic official close to the talks also declined specific comment and said, "It's not clear they will be able to bridge the gap" to craft a bipartisan agreement.

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Several other year-end issues—doctors payments under Medicare, unemployment benefits and tax breaks for business—are also on the table and part of the 11th-hour horse-trading.

Mr. Obama deputized Senate leaders to craft a compromise at a Friday meeting designed to dispel widespread gloom about Congress's deadlock.

"Congress can prevent it from happening, if they act now," Mr. Obama said Saturday in his weekly radio address. "Leaders in Congress are working on a way to prevent this tax hike on the middle class, and I believe we may be able to reach an agreement that can pass both houses in time."

Senate Minority Leader Mitch McConnell (R., Ky.) made an unusual Saturday visit to his Capitol office. Asked whether he expected he would reach an agreement with Mr. Reid he said, "I hope so."

Mr. Reid has said that if they do not reach an agreement, he will have a vote by Monday on legislation that would be a bare-bones effort. It would increase taxes on income over $250,000, extend expiring unemployment benefits and block the expansion of the alternative minimum tax.

Any tentative agreement that is struck between the leaders and their staff will be presented to Senate Republicans and Democrats in separate party meetings Sunday afternoon, when the Senate is set to reconvene.

Senior Republican aides said a key GOP demand is that Mr. Obama move off his insistence that tax rates rise for income over $250,000 in favor of level of $400,000 or $500,000, to reduce the number of people and small businesses that face higher taxes. Mr. Obama has not ruled out that idea. Some Democrats say Republicans must offer a substantial concession in exchange.

Republicans view the extension of unemployment benefits, which expire for many jobless people Dec. 31, as such a concession, especially if its cost is not offset with spending cuts in other programs.

Another major issue for many Republicans is the estate tax, which is slated to jump from 35% to 55% on Jan. 1 on estates worth $1 million or more. Most Republicans and many Democrats in farm states, who think a high estate tax hurts family farms, want to keep the rate at 35%, which applies to inheritances over $5.12 million.

Mr. Obama and many other Democrats want the tax to be set at 45%, applying it to inheritances over $3.5 million. Some liberal Democrats are worried that a deal with Republicans would give too much ground on the estate tax. That could cost support among House Democrats, according to a senior Democratic aide.

Any deal is likely to include a bipartisan measure to block a scheduled expansion of the alternative minimum tax, a levy created in the 1960s to hit only the wealthy that every year threatens to raise taxes on millions of families.

Beyond those must-pass tax issues are other options being debated by negotiators. One senior GOP aide said that the limited time available may make it difficult for the package to be as ambitious as some would like, which means major issues will be left to be addressed after New Year's.

"We are spending time today thinking about how much they can get in, but this is not a strong horse" to carry a heavy load of other issues, the GOP aide said.

Members of both parties also want to block a scheduled cut in Medicare payments to doctors, but some Republicans want the expense to be offset by spending cuts in other programs.

Republican aides say it is unlikely that the year-end deal will postpone or replace the $110 billion in domestic and defense spending cuts set to take effect Jan. 2, despite bipartisan fears about the impact of those cuts on the Pentagon and the weak economy.

If Messrs. McConnell and Reid do not reach an agreement, tax increases could still be averted for most people if Congress passes Mr. Obama's backup proposal to extend current rates for income up to $250,000. Democrats are confident they could pass the bill through the Senate. A key question is whether the House would approve it if only a handful of Republicans are in favor.

Officials say they see a path to timely approval of a bipartisan bill: If a Reid-McConnell deal could be struck by Sunday morning, it could be presented to Senators in closed-door party caucuses Sunday afternoon, approved by the Senate Sunday night or Monday morning, then sent to the House, which reconvenes Sunday night.

House Republicans, who recently refused a proposal to raise rates on only income over $1 million, are scheduled to meet in a closed-door party meeting Monday morning, when they presumably would review what the Senate has delivered.

One scenario that could ease the political pain for reluctant House Republicans: If they wait until Jan. 2, after the tax increase takes effect, their votes would amount to a vote for a tax cut.

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